As the mortgage market continues on a roller coaster ride of foreclosures, denied applications, and wildly adjusting interest rates, understanding your mortgage and escrow on your home is critical. With property values fluctuating, some homeowners may find their fixed rate payments increasing or decreasing due to the behavior of their mortgage-associated escrow account.
What is Escrow?
To help homeowners cope with sometimes weighty homeowners' insurance and property tax payments, many mortgage lenders set up an escrow account as part of the regular mortgage payment. This account is designed to collect enough money to cover the homeowner's insurance and property taxes, which the mortgage lender will take care of without requiring additional payments. This may seem convenient and simple, but there are several factors that can make an escrow account a surprise problem in an otherwise unsurprising mortgage.
What Influences Escrow
Two things generally influence an escrow account the most:
- Property tax on the home
- Homeowner's insurance policy
Both of these factors can adjust annually, proportionally increasing or decreasing the required payments to the escrow account and therefore affecting the monthly mortgage payment, even if the mortgage interest rate is a fixed rate or has remained the same.
Property tax is the most likely factor to affect an escrow account. In areas where the population - and therefore housing prices - is rising rapidly, cities may increase property taxes to pay for additional utilities, road developments, parks, schools, and other community facilities needed to support a growing population. Even areas where property values are declining could see an increase in property taxes to help fund city budgets for additional public service personnel, new recreation centers, hospital expansions, or other publicly funded projects. An increase in property tax means that even a fixed mortgage loan may not collect enough in the escrow account to cover the tax increase, resulting in a higher payment.
If property taxes are lowered, however, homeowners may not see any adjustment to their escrow payments and their mortgage payment may remain the same. Instead of an adjustment to the monthly payment, a refund of excess escrow funds may be issued after property taxes and homeowners' insurance premiums are paid. Some companies, however, will offer homeowners the option of lowering their escrow contributions to avoid overpaying, which will in turn lead to a lower mortgage payment.
Homeowners' insurance is another major part of escrow payments, but it adjusts less frequently and in some cases, will not be adjusted except at the request of the homeowner. While some homeowners will opt to leave their insurance the same as when they first bought the house, it is wise to reevaluate the coverage annually to be sure it is adequate in case of fire, flooding, or other damaging circumstances.
This is particularly critical if the homeowners have bought new furniture or electronics, made home improvements such as a new roof or fireplace, or if the property value has dramatically increased and it may not be possible to rebuild or repair a home with outdated and inadequate insurance coverage. By changing the insurance - and therefore part of the escrow account - to meet changing needs, homeowners can adjust their payment to coincide with their new insurance needs. If homeowners are interested in taking this route simply to find a lower payment, however, they should speak with both their mortgage loan officer and their insurance agent to ensure they are adequately protected and that their loan can be covered by insurance if necessary.
How Escrow is Part of Monthly Payments
Both fixed rate and adjustable rate mortgages may have escrow accounts. On a typical mortgage statement the total payment will be broken down with figures for the principal payment (made on the loan balance), the interest paid, and the amount put into the escrow account. When making the payment homeowners have the option to pay extra into the escrow account, which is a wise choice if they know the property taxes or insurance may be rising and they want to avoid the brunt of the increase all at once. While the amount paid to the principal and the interest will change each month as the balances and rates adjust, the amount paid to the escrow account should remain the same.
Understanding Your Mortgage and Escrow on Your Home: When Your Escrow Changes
When property taxes and homeowners' insurance policy changes are reported to the mortgage company, the homeowner should receive a statement summarizing how those changes will affect their escrow balance and future payments. Homeowners are generally given several options:
- Do nothing, and payments will automatically be adjusted to compensate. Depending on the rate of tax or insurance increases, this could add just a few dollars to each monthly payment or it could add $100 or more to the amount due, which can be a tight stretch for homeowners on a strict budget.
- Pay the shortage immediately. If homeowners will have an inadequate escrow account, they can opt to pay the entire deficit right away and their monthly payments will remain the same. This means that the following year their escrow account may again be underfunded unless further drastic changes in property tax or insurance take effect.
- Pay part of the shortage immediately. If homeowners do not have the full amount of the shortage available, they can pay a portion of it to keep their mortgage payments from adjusting drastically. Again, this may mean that the following year their escrow account is still short and additional payments may be necessary.
In this troubled housing market and shaky economy, even small mortgage payment increases can be devastating to families on a tight budget. By understanding your mortgage and escrow on your home, homeowners can plan for necessary adjustments and shortages without risking payment penalties, foreclosure, or other financial hardships.